Low cost of crude could fire up shale deals

Risky debts mean small independents might be consumed

Oil field services giant Halliburton is a regular at the Offshore Technology Conference in Houston. Halliburton is buying a rival, Baker Hughes. ﻿

Photo: Thomas B. Shea, Freelance

Cheap oil could set off a wave of corporate fire sales over the next two years if oil prices remain low, investors and financial experts say, putting a patchwork of oil wells from Texas to North Dakota in the hands of bigger, richer players.

A number of small independent oil companies may have to hand over the keys to oil pumping assets or their entire companies if they can't pay back billions in risky debt that has fueled hydraulic fracturing and a big gain in U.S. tight oil output over the past few years.

Oil prices, experts say, would need to stabilize at low levels for a few months to kick-start the series of mergers and acquisitions.

The $200 billion poured into speculative shale energy bonds, as well as hundreds of billions in high-risk leveraged loans, will cut into the level at which those companies can make money on cheaper oil, as estimates of the industry's so-called break-even points in U.S. shale plays assume oil-company balance sheets are blank slates, without significant debt obligations, said Praveen Kumar, a finance professor at the University of Houston.

"The problem is a lot of the smaller companies have aggressively taken on debt," Kumar said. "They're in a real bind because in the last few years they took a bet on $90 oil. Some of them, I think, aren't viable at $70 a barrel."

That doesn't mean the growth in U.S. oil production will slow anytime soon - and if it doesn't decrease, that could continue to weigh on oil prices. Even if some smaller companies default on their debt or can no longer pump capital into drilling, their oil wells will likely find their way to other companies or private equity firms, one way or the other.

One sign that production may not throttle down quickly: Most of the Texas drilling rigs that have come off the market because of lower oil prices so far are the older vertical-drilling rigs that are less efficient and less productive than the horizontal rigs that move quicker on multi-well platforms called pads, Barclays analysts wrote last week.

And because of the advent of pad drilling, Texas' oil production hasn't stalled even as the number of oil well completions has fallen, according to the British bank.

"Despite lower drilling permit submissions, lower rig counts and lower well completions, we are not yet convinced that a decline in production growth is imminent," the analysts wrote.

More deal-making

Deal-making in the industry rose in 2014, as U.S. oil and gas transactions generated $165 billion in proceeds during the year, the highest amount in 16 years and 78 percent higher than 2013, according to Dealogic.

And there are signs that the U.S. oil deals are beginning to be driven by the need to consolidate amid falling prices: Halliburton's $35 billion proposed acquisition of Baker Hughes late last year, the biggest energy deal recorded by Dealogic in 2014, was in part hastened by falling crude prices.

Big oil companies and investment firms will shop around a lot more for assets on the fringe of the best U.S. shale plays or for companies with too much debt, said Adrien Reed, managing director at Berkeley Research Group in Houston.

Kumar said it'll give companies like Exxon Mobil Corp., Chevron Corp. and others a chance to dig a new foothold into regions they had largely missed out on in the U.S. shale land rush, which favored the small and nimble. And bigger shale oil players, like Houston's EOG Resources, may pick up some assets as well, he said.

"There will be a shakeout, but it's going to be the smaller shale firms with a lot of short-term debt that are going to sell themselves at fire sale prices ... to some of the deeper-pocket companies," Kumar said.

Filling portfolio holes

Fraser McKay, an analyst at research firm Wood Mackenzie, said many larger companies are looking to fill holes in their portfolios by buying smaller drillers.

"There are strategic gaps, whether intentional or unintentional, in some of the large companies' portfolios such as deep water or unconventional, and there are smaller companies that fill those roles," McKay said.

Several U.S. oil producers have laid out plans for smaller budgets this year. Falling capital expenditures will mean there could be more unloved oil projects that companies wouldn't mind letting go. When oil price first began to fall in October, Anadarko Petroleum Corp. CEO Al Walker told investors lower oil prices - once they stop dropping and find equilibrium - are going to generate more attractive deal prospects.

"We think the environment, where it is currently, may bring opportunities to acquire things in the basin that may be advantageous to us," Walker had said.

Some doubts

Private equity executive Carl Tricoli says he's skeptical the acquisition stream will begin in at least the next six months, or anytime before oil prices find a new bottom.

"I think back to the financial crisis, where we were all licking our chops thinking 'this is going to be awesome,' " said Tricoli, managing partner at private equity firm Denham Capitalm, which has its main offices in Boston and Houston. "We thought it would be an opportunity-rich environment. We thought there's going to be all these defaults, and it turned out not to be that at all."

Different this time?

But this oil bust could be different: Unlike in 2008 and 2009, the U.S. economy is growing, banks are healthier and in a better position to divest from oil fields and the oil industry is retreating faster to core oil regions, leaving a lot of land untouched, said Tony Weber, managing partner at Irving-based private equity firm Natural Gas Partners.

"In many ways price equity is a replacement for high-yield bonds," Weber said. "Today, the high-yield market is all but closed except for the highest-quality issuers. We're seeing investment opportunities like crazy."

'Market discipline'

While the U.S. economy is benefiting from lower gasoline prices, Houston's oil-driven economy is expected to see cutbacks in investments and job losses.

Joe Brusuelas, chief economist for Chicago-based accounting firm McGladrey, said Houston "is going to go through a period of market discipline, and then adjust accordingly."

Brusuelas said the new market discipline will wash out inefficient, debt-laden oil companies - many of which were previously protected by high oil prices - in a surge of corporate sales.

That, Tricoli said, will make the industry more profitable when oil prices rise again.

"When you're in a lower price environment, that's when people figure out how to be profitable in a lower price environment," Tricoli said. "It makes the industry more competitive at a lower price range."

Energy reporter for the Houston Chronicle. Houston native. Former banking and finance reporter.

Prior to joining the Houston Chronicle, Collin Eaton covered the local banking and finance scene at the Houston Business Journal. Before that, he held internships at newspapers in Texas and Washington D.C., generally writing about business, money or higher education. He graduated from the University of Texas at Austin in 2011.